Real life implementation of modern portfolio theory (MPT) for financial planning and portfolio management

ABSTRACT

An investment portfolio management method and system. The method is developed using mathematical models and implemented via the Intra- and Internet technology. The method is a comprehensive personal financial planning business model. With this method a conventional mean-variance efficient portfolio frontier analysis, which is often cited in Modern Portfolio Theory (MPT), one of the major scholarly developments in modern finance, finds its way into actual securities trading and rebalancing in real world. MPT is modified to allow various transactions costs, e.g. bid/ask spread, brokerage commissions, taxes, and others; as well as non-stationary securities return distributions to form efficient portfolios in real time by way of various portfolio rebalancing strategies. The system offers an automatic, mathematical solution for asset allocation and cash management in real time, while managing and trading on portfolios of each asset class, e.g. commercial papers, repurchase agreements, money market funds, bonds, stocks, mutual funds, and other derivatives on an auto mode.

[0001] The present invention relates generally to a system and method offinancial planning and portfolio management and, more particularly, to asystem and method of selecting and managing a portfolio of investmentassets for maximizing investment returns under a set of user-specifiedinvestment preferences or strategies.

BACKGROUND OF THE INVENTION

[0002] Modern Portfolio Theory (MPT), especially in the context ofCapital Asset Pricing Model (CAPM) first developed by William Sharpe andJohn Linter, assumes that an investor maximizes his/her terminal wealthby investment portfolio decisions made today. In making investmentportfolio decisions, an investor attempts to examine every possibleinvestment opportunity to form an efficient portfolio frontier and picksthe most efficient portfolio vector for maximizing an investment return.Since every prudent investor would do this, the most efficient portfoliothat he or she picks would be the same for all, given risk-free lendingand borrowing rates. Such an investment portfolio is known as a marketportfolio.

[0003] However, people differ in their risk preferences. Consequently,some investors might mix their investments in a market portfolio withrisk-free or less risky assets, while others might prefer to investexclusively in the market portfolio with borrowed funds. Alternatively,people might hold a well-diversified mutual fund, which generally willresult in a similar risk-return profile as those achievable by anindividual portfolio, which combines a market portfolio and risk-freeassets under the CAPM theory.

[0004] However, determining how individual asset returns are generatedunder conditions of market uncertainty is not provided by MPT. This hasnot only been a crucial element missing from MPT, but is also animportant consideration to all investment practitioners in real worldtrading, because each individual security return would eventuallydetermine the expected returns and variance of every portfoliocontaining that security and, hence, will determine the shape of theefficient portfolio frontier under MPT.

[0005] The originally developed CAPM has very little to say about howeach individual security return is generated. Various improvements tothe original CAPM have been proposed, such as the Single Index CAPM andvarious other forms of Multi-Factor CAPMs (with or without varioustaxes, transaction costs, inflation rates, and the like). On the otherhand, Arbitrage Pricing Theory (APT) by Steve Ross proposes thatwhatever results the CAPM may have produced must be a result of theinvestor arbitrage. As a result, Professor Ross starts out with thetheory of a k-factor return generating function for each individualsecurity; and assumes that every investor would be interested in makingrisk-free profits by forming an arbitrage investment portfolio utilizinghis pre-specified return generating function of linearity for eachindividual security. According to Professor Ross' theory, the finalpricing formula for capital asset prices would be similar to that of theCAPM.

[0006] Factors determining individual security returns are proprietaryto every security analyst. Every portfolio manager has his/her own setof factors. Generally, what determines the security returns follows areturn generating function in a form described in equation (1) below$\begin{matrix}{R_{i}\Delta_{i}\underset{i\quad 1}{\overset{k}{f}}E_{i\quad j}F_{j}H_{\tau}} & (1)\end{matrix}$

[0007] where R_(i) is a rate of return on a security, i; F_(j) is aneconomic factor, j, affecting all security returns; Δ_(i) is aregression constant; E_(ij) is a sensitivity of the return on asecurity, i, with respect to a change in factor, j. Those j factors mayinclude industry identifiers, the inflation rate, the unemployment rate,exchange rates, economic growth rates, interest rates, and so forth.

[0008] Since an investment portfolio return is defined as${R_{p}\underset{i\quad 1}{\overset{k}{f}}X_{i}R_{i}},$

[0009] where X_(i)'s are respectively a proportion in which aninvestment is made in a security, i, the expected return E and thestandard deviation σ for a risky portfolio are respectively defined as$\begin{matrix}{{E > R_{p} \cong {\underset{i\quad 1}{\overset{n}{f}}X_{i}E} > R_{i} \cong},{and}} & (2) \\{\varsigma_{p}^{2}\underset{i\quad 1}{\overset{n}{f}}X_{i}^{2}_{i}^{2}\underset{i\quad 1}{\overset{n}{f}}\underset{\underset{j\quad \zeta \quad i}{j\quad 1}}{\overset{n}{f}}X_{i}X_{j}_{i\quad j}} & (3)\end{matrix}$

[0010] Techniques of maximizing the portfolio's expected return,E[R_(p)] and minimizing the portfolio's risk, ζ_(p) ², have been welldocumented in many finance textbooks. However, the proposed techniquesare often inadequate or even incomplete from most investors' point ofview.

[0011] For example, the market portfolio under MPT exists only intheory. Since the market portfolio as suggested in MPT is only atheoretical construct, it is possible that efficient portfolios selectedby sub-sampled stocks may outperform (or underperform) any availablemarket benchmark index, which many investors use as a proxy for themarket portfolio. Furthermore, properties of the probabilitydistribution for security returns, as are given in equation (1), are notconstant over time. To understand this, a great deal of theoreticalresearch has been done in the area of MPT by utilizing variousstochastic process models. However, there has been no definiteconclusion as to how an individual portfolio should readjust itself toan optimum portfolio in a dynamic stochastic model. Consequently, it isquite difficult for an investor to plan ahead to maximize his terminalwealth when the probability distribution parameters change in the faceof constantly changing investment environments in real time. Inaddition, there has been no known computational facility currentlyavailable to individual investors through the Internet or othercommunication channels designed to show how an optimum portfolio shouldbe formed or approached by taking into consideration all assumptionsmade in MPT.

[0012] Moreover, no known tool incorporating efficient portfoliomodeling theories (e.g., CAPM) is currently available to investorsthrough the Internet, or other communication channels, that is designedto provide many desirable features in helping investors to make theirinvestment decisions with respect to portfolio management. Consequently,individual investors often have to rely on professional portfoliomanagers in making investment decisions using, among others, theabove-mentioned market portfolio theories. These desirabledecision-making features may include:

[0013] To show how one can pick a scenario portfolio, which mayoutperform a given market index by selecting stocks through (i) variousstock screening features, (ii) back tests, and/or (iii) virtual trades;

[0014] To show how one can better manage his or her portfolios byrecognizing the bid/ask spread, brokerage commissions, potential taxobligations, etc., in real time;

[0015] To show how one can attempt to re-balance his or her ownportfolios by suggesting various criteria or preferences with a possibletrading band;

[0016] To present a financial statement for each one of their investmentportfolio accounts;

[0017] To show how a risk level rises or falls in real time, as he orshe manages his or her own portfolios;

[0018] To execute and settle orders automatically in real time,especially those orders involving a basket of securities;

[0019] To show automatically how investors could allocate investmentassets in real time; or

[0020] To provide various investment calculators for investment analysispurposes.

SUMMARY OF THE INVENTION

[0021] It is a general object of the present invention to provide asystem and method capable of interacting with a user for receiving userdeterminable values or preferences of investment parameters to beinputted into the system for generating an investment scenario portfoliobased on the user defined parameters.

[0022] It is another object of the present invention to provide userinteraction with a computer network system over the Inter or Intra-netfor assisting the user in defining user determinable parameter values orpreferences and for monitoring in real time an existing (or a scenario)portfolio generated by the computer network system based on the userinputs.

[0023] It is yet another object of the present invention to provide asystem and method capable of automatically re-balancing existing and/orscenario portfolios based on the user determinable parameter values andof automatically executing trades of securities to form a new portfolio.

[0024] In one embodiment, the present invention comprises a computerserver connected to a client system through a first network andconnected to computers of a plurality of brokerage houses through asecond network, wherein the computer server has one or more mathematicalcomputational models for computing optimized portfolios based on varioususer-determinable portfolio rebalancing strategies or preferences andhas an executing engine for executing security trades in response toresults of the calculated optimized portfolios, either automatically ormanually as directed by a user.

[0025] The above-stated objectives are for illustrative purposes and,thus, do not limit the scope of the present invention. Additionalfeatures and advantages of the present invention will be set forth inthe descriptions that follow. The objectives and other advantages of theinvention will be realized and attained by the structure particularlypointed out in the written description and claims hereof as well as theappended drawings. It will be further understood that the drawings arefor purposes of illustration and are not to be construed as defining thescope of an invention.

BRIEF DESCRIPTION OF THE DRAWINGS

[0026]FIG. 1 shows a basic implementation of the present invention.

[0027]FIG. 2 shows an Expected Risk Premium chart demonstrating the wayin which an optimum scenario portfolio is determined with its expectedrisk premium to risk function.

[0028]FIG. 3 shows a three-tier logic structure in functionalarchitecture overview of the present invention.

[0029]FIG. 4 shows another three-tier logic structure in functionalarchitecture overview of the present invention.

[0030]FIG. 5 shows a three-tier logic structure in query functional modeof the present invention.

[0031]FIG. 6 shows a three-tier logic structure in monitoring/graphfunctional mode of the present invention.

[0032]FIG. 7 shows a three-tier logic structure in userregistration/preferences functional mode of the present invention.

[0033]FIG. 8 shows a three-tier logic structure in financial databasefunctional mode of the present invention.

[0034]FIG. 9 shows a three-tier logic structure in platform overview ofthe present invention.

DETAILED DESCRIPTIONS OF EMBODIMENTS

[0035] The present invention entails a method and system for managinginvestment portfolios through a mathematical model and electronicon-line or off-line trading via the Inter- or Intranet communicationstechnologies. The method is an integrated financial planning packagethat can be delivered directly to an individual investor/user and/orother investment professionals. The present invention is capable ofmanaging cash (or cash equivalent) accounts as well as all otherinvestment accounts in fixed income bonds, stocks and other financialassets including derivatives either singularly or collectively both inautomatic and/or manual modes.

[0036]FIG. 1 illustrates a basic physical configuration and proceduralsteps of a preferred embodiment of the present invention.

[0037] Step 1

[0038] A user will be asked to give detailed information regardinghis/her individual investment preferences using an HTML form on a clientsystem 10 and received by a computer server 20. The computer server 20is connected to the client system 10 through a network 30. The network30 can be a wired or a wireless communication network capable offacilitating Internet or Intranet services to the client system 10.Consequently, the computer server 20 may receive from the client system10 the user's investment preferences, criteria or strategies such asinvestment horizon, minimum cash reserve, annual target return, desiredrisk level, stop loss, upper/lower limits for portfolio rebalance,return tolerance, and other strategic rebalancing strategies. Uponreceiving input information from the user the computer server 20 mayupdate a database maintained by the computer server 20 and containinginvestment profile information of the user.

[0039] Step 2

[0040] The computer server 20 sends criteria queries to the clientsystem 10 using additional HTML forms to define the details of ascenario portfolio the user wishes to create. The user on the clientsystem 10 will define his/her investment styles by choosing a set ofuser determinable fundamental, technical and/or other market valuecriteria. The computer server 20 will then process these query criteriareceived from the user and will select securities in response to theuser defined criteria to satisfy the user requirements in styles andpreferences of investments, and will save these selected securitiesinformation for future reference.

[0041] Step 3

[0042] From the client system 10, the user can invoke a mathematicalanalysis engine or program on the computer server 20. The mathematicalanalysis program on the computer server 20 will retrieve all the userdefined investment data and configuration associated with the user. Themathematical analysis program will also load the stock informationcurrently under analysis, such as the real time prices for these stocks,and will calculate a cash balance of the existing portfolio. UsingModern Portfolio Theory (MPT) as the basis of its calculation, thecentral computer server 20 formulates an investment index, which isfundamental to constructing an optimized scenario portfolio. Thecomputer server 20 ranks the set of stocks against the user preferencesand outputs a list of recommended stocks and/or the numbers of shares ofeach recommended stock to buy or sell against the existing portfolio inorder to form an optimum scenario portfolio. The portfolios arecontinuously monitored by the computer server 20 and when apre-determined triggering event occurs, a trade recommendation will besent to the user through the Internet, Intranet or other communicationchannels.

[0043] Step 4

[0044] Each calculation by the server 20 is compiled into a readableresult set with recommended trade decisions and displayed for the uservia an Internet site, Intranet site, or on other display devices such asnet appliances. The user on the client system 10 will receive the traderecommendations in a format such as an HTML form or Java applet.

[0045] Step 5

[0046] The user on the client system 10 can specify to execute the traderecommendations either in an automatic mode or in a manual mode. Usingthe automatic mode, all trade decisions will be executed automaticallyand independent of user administration and monitoring. With the manualmode employed, the user will receive all trade recommendations generatedby the computer server 20. Thus, the user can decide whether or not toaccept these trade recommendations. All information regarding securitytrades are sent to the computer server 20 by the user and are executedby the computer server 20. When the user deploys the manual-tradingmode, he or she can approve all, some or none of the recommendationsfrom the recommendation set. Alternatively, the user may specify auser-selected stock for the computer server 20 to trade.

[0047] Step 6

[0048] The present invention will run at predetermined regular intervalsto monitor the performance of the user's existing investment portfolio.The present invention will also regularly generate an optimal scenarioportfolio based on the user's data and market conditions and willcompare expected returns on the scenario portfolio against that of theexisting portfolio and market index returns. Performance is measured forperiods since the inception of the existing portfolio and the last tradedate leading up to the present existing portfolio. Performancemonitoring will affect the trade decision recommendations being sent tothe investor (i.e., the user).

[0049] With this method and system, MPT is implemented in such a waythat a client portfolio selected will satisfy not only the investor'starget return and risk requirements in real time but also the investor'sinvestment planning horizon; investment styles; benchmark; the bid andask spread; brokerage commissions; various taxes, and so forth.

[0050] Further details as to the mathematical model, the userdeterminable investment parameters, criteria or preferences, thephysical configuration, and other considerations according to thepresent invention are described below.

[0051] Basic Structure

[0052] In the preferred embodiment, the present invention is anintegrated personal financial planning system, or a system of securitiesinvestments in general, providing various analytical tools, accountingstatements and securities order/execution systems through the Intra-,Internet or other communication technologies. The present inventionprovides investors with a complete integrated set of financial tools andalgorithms to help the investors trade securities like a professionalfund manager.

[0053] First, through a series of investor questionnaires in the form ofHTML forms or the like provided to the user by the computer server 20over a network 30 such as the Internet, the user can specify hisexpected target return, R_(T), for his entire investment portfolio(inclusive of his cash balances) and make revelation about hispreferences toward risk in terms of beta, β_(T). The present inventionmay implement this task through investor questionnaires. For example, acertain range of beta coefficients may lead to aggressive growth, whilecertain other beta values may be conservative in nature insofar as therisk preference is concerned. Given the rate of interest paid on hiscash management account and on Treasuries; and the return on the marketbenchmark, R_(m), an optimal allocation between his cash managementaccount and his investment portfolio is given by:

R _(T) ZR _(c)(1Z)R _(I)

[0054] R_(T) is the expected return on his investment portfolio. Thesymbol, ω, is the proportion invested in cash or cash equivalent assets,e.g. money market funds, Repurchase Agreements, CDs, and the like, andconsequently, (1−ω) is the proportion invested in a portfolio of riskyassets. R_(c) is the return on the cash account and R_(I) is the rate ofreturn on a portfolio of risky assets. Under MPT, R_(I) can be furtherdefined as

R _(T) R _(c)(R _(m) R _(c))E _(I)

[0055] In view of the fact that R_(m) is almost impossible to measure inreality, the present invention bases its return on the market benchmark,R_(m), based on the investor's investment styles, e.g. small caps, valuestocks, etc., unlike in the case of MPT. This return on the marketbenchmark will be one of the major advantages in the present inventionas will be discussed later below.

[0056] An optimal asset allocation, φ, between fixed income and equitysecurities is given by:

R _(I) IR _(b)(1I)R _(s)

[0057] The expected return on a risky portfolio, R_(I), will be computedby maximizing an objective function, (R_(I)−R_(c))/σ_(I) with respect toI's, proportion in which bonds and stock portfolios are combined to forman optimal asset allocation. The symbol, σ_(I), is the standarddeviation of the portfolio's return.

[0058] Expected returns and the standard deviation on a bond and stockportfolio will be determined separately. First, given the investor'sinvestment planning horizon, for example, a duration matching principlecan be employed along with the bond's convexity and the yield tomaturity to compute the bond portfolio's anticipated horizon yield.Second, an optimal equity portfolio can also be formed by a maximizingfunction, (R_(s)−R_(b))/(σ_(s)−σ_(b)), similar to the maximizingfunction introduced previously. Finding the optimal value of theexpected return and the standard deviation for the equity portfolio willthen be a routine mathematical solution. Selecting a set of mutual fundsis straightforward and will follow a similar procedure. Thus the presentinvention determines the investor's asset allocation, cash managementaccount, optimal bond, stock or even mutual fund portfolios in real timewhile managing the user's investment risk automatically. For example,risk can be measured by using a “Risk Thermostat” according to aformula:

E _(I) I _(b)(1I)E _(s)

[0059] The optimal asset allocation thus obtained by the presentinvention for the portfolio may differ from what the user wishes toallocate, in which case the expected return on his aggregate investmentportfolio, R_(I), will be recomputed by using the investor-specifiedasset allocation. This will result in a change in ω and β_(I). Anoptimal portfolio of risky assets will be described as follows.

[0060] As FIG. 2 illustrates, first, securities will be ranked in adescending order according to their expected return premium to riskratios, the risk being defined as similar to the above-mentioned beta,see the declining portion of the graph. Beta for the present inventionis similar to but different in several aspects from the traditional MPTbeta, in the sense that security returns are not regressed against whatis often considered as the aggregate market index, e.g. Dow Jones, S&P,etc., but against a market index which represents a particular group ofsecurities satisfying the investor style requirements. Each userportfolio may have a peculiar market index generated by the computerserver 20 based on the individual user input information, criteria,preferences, etc. Second, scenario portfolios will be formed byconsidering a portfolio of the best or highest ranked securities, aportfolio of the best and the next best securities, a portfolio of thebest, the next best, and the next, next best securities, and so forth.(See the inclining portion of the graph in FIG. 2). Third, an optimalportfolio is determined where a marginal contribution of an additionalsecurity to the portfolio turns negative. (See the point denoted by E inFIG. 2). Fourth, the proportion in which investments should be made ineach security in the portfolio is determined according to thecontribution that each security makes to the portfolio. If the entirecontribution made by all securities in the portfolio can be representedby the shaded triangular area in FIG. 2, the contribution that eachsecurity makes to the portfolio is that portion of the shaded areacorresponding to each security. This is similar in concept to what isknown as “consumer surplus” in basic economics.

[0061] A personal financial planning worksheet can be constructed basedon the investor's initial and future regular investments showingpossible and/or desirable future investment returns from eachinvestment. The worksheet can be readjusted by the investor along withportfolio rebalances in regular time intervals, e.g., every day, everymonth, or every 3 months, etc.

[0062] Given the investment objectives, preferences and styles providedby the user, the computer server 20 runs an algorithm based on one ormore of the computational mathematical model(s) stored in the computerserver 20 to form an optimal initial scenario portfolio. In addition,the investor's target return will be used to automatically compute itsaccompanying risk, which will be used to determine an optimal size ofthe scenario portfolio. Expected returns on the scenario portfolio arealso calculated. To form an initial portfolio, the expected returnshould exceed the investor's target return and the expected returns onthe aggregate market benchmarks, e.g., the Dow Jones, etc. Once theinitial scenario portfolio is formed, the performance of the scenarioportfolio will be constantly monitored in real time. A subsequentalgorithm would be run by the computer server 20 in every pre-specifiedfixed time interval to suggest a different composition or configurationof risky securities. Expected returns on a new scenario portfolio arecompared with those on the pre-existing portfolio and the marketbenchmarks. The computer server 20 may then report the comparisonresults to the investors via Inter-, Intranet, or other communicationchannels.

[0063] As compared to the Capital Asset Pricing Model (CAPM), whereinsecurities are priced under the assumption that the probabilitydistribution parameters for security returns are stationary or thatsecurity prices follow various stochastic diffusion processes, thepresent invention dynamically changes distribution parameters forrebalancing portfolios, existing or scenario, to achieve efficiency. thepresent invention also suggests various re-balancing strategies bycomparing the expected returns on the existing portfolio to those onscenario portfolios subject to a user specified parameter referred toherein as the trading band limit. The trading band limit defines bothlower and upper bounds at which the user's portfolio may require arebalancing trade. If the user sets the band high at a level,rebalancing trades may occur less frequently than when the band is setlow.

[0064] The investor may specify a desirable frequency of rebalancingbased on how actively the investor wishes to manage his funds. Examplesof re-balancing strategies are shown below. In one embodiment and forpurposes of illustration only, the following symbols are defined fordemonstrating the present invention.

[0065] E[S] An expected return on a scenario portfolio

[0066] v A value of a new scenario portfolio divided by that of anexisting portfolio

[0067] E[0] An expected return on the existing portfolio

[0068] E [M] An expected return on the market benchmark

[0069] G A geometric return on the existing portfolio since inception

[0070] H A holding period return on the existing portfolio since lasttrade

[0071] HS A holding period return on the existing portfolio sinceinception

[0072] ST Stop loss since inception. Default=10%

[0073] T Target return

[0074] M A geometric return on the benchmark portfolio since last trade

[0075] m A holding period return on the benchmark portfolio since lasttrade

[0076] L A lower bound filter. Default=−0.75%

[0077] U An upper bound filter. Default=1.5%

[0078] S A current value of the existing stock portfolio

[0079] In addition, the following nine (9) different trading modes arealso defined for further illustration of the present invention.

[0080] (1) Initial Mode

E[S]v>T>E[0]  1.1

E[S]v>E[M]  1.2

[0081] (2) Stop Loss Mode

[0082] During monitoring of the portfolio, if the investor's stop losslimit is x % and if HS<−x % and S>0 then the present invention willattempt to liquidate the investor's entire holdings and puts them into acash account. A HOLD flag will be clear and a TRADE flag will be setwith a query message like “Your portfolio has reached your stop loss. Doyou wish to have your investment liquidated to limit losses?” to theinvestor. If a reply from the investor is affirmative, SELL orders ofsecurites will be automatically executed. If the reply is negative, thesystem is resumed back to normal mode to continue monitoring theportfolio performance.

[0083] (3) Redemption Mode

[0084] When HS>T and S>0 for the existing portfolio, the system willprompt with a query message like “You have now achieved your targetreturn. Do you wish to have your investment redeemed?” to the investor.If the reply is affirmative, a REDEMPTION flag is set and a redemptionalgorithm gets executed by the computer server 20. If negative, thesystem resumes back to the normal mode to continue.

[0085] (4) Buy & Hold (P-) Mode

[0086] When E[S]v>T>E[0], the EPS is in a Buy & Hold mode. As such, thesystem will attempt to buy securities either already listed in theexisting portfolio or listed in a scenario portfolio. The system willcompare the existing portfolio against the scenario portfolio and willdetermine which and how may shares of the securities in the existingportfolio need to be traded.

[0087] (5) Market (M-) Mode

E[S]v>M>E[0]  M1.

E[S]v>E[M]>E[0]  M2.

[0088] (6) Bear (R-) Mode

E[M]<M

[0089] (7) Bull (B-) Mode

E[M]>M

[0090] (8) Lower Filter (L-) Mode

H<0  L1.

ABS(Hv)>ABS(L)  L2.

ABS(m−Hv)>ABS(L)  L3.

[0091] (9) Upper Filter (U-) Mode

H>0  U1.

Hv>U  U2.

(Hv−m)>U  U3.

[0092] Based on the user determinable parameters or values mentionedabove, the following rebalancing strategies by the present invention arepossible.

[0093] (1) Buy and Hold Strategy

[0094] TRADE only if P-Mode satisfies.

[0095] (2) Managed Strategy

[0096] HOLD will change to TRADE, if E[S]v>E[0]; and

[0097] R-Mode and L-Mode; or

[0098] B-Mode and U-Mode

[0099] (3) Benchmark Strategy

[0100] If E[M]<M, TRADE if both (M1) and (M2) satisfy.

[0101] If E[M]>M, TRADE only if (M2) satisfies.

[0102] (4) Passive Benchmark Strategy

[0103] TRADE if both P-Mode and conditions for Benchmark Strategysatisfy.

[0104] (5) Managed Benchmark Strategy

[0105] TRADE if conditions for both Managed and Benchmark Strategiessatisfy.

[0106] (6) Profit Only Strategy

[0107] TRADE if P-Mode and the condition that Hv>(L+U)/2 satisfy, e.g.Hv>(−0.75+1.50)/2=0.375%

[0108] Managed strategies using L- and U-Modes can be further simplifiedby introducing the trading band (TB) parameter defined as TB=(L+U)/2,where L=−U/2. When TB is set by the investor, it would automatically setvalues of L and U.

[0109] Actual portfolio weights achieved under various realisticconstraints to parameters mentioned above may differ considerably fromoptimal weights as suggested by the mathematical algorithm in thecomputer server 20. This would be so, especially when the available cashof a particular investor may be limited to buy enough shares ofsecurities, as the system would have recommended. Thus it would beunrealistic to achieve the same expected return on an existing portfolioas that from a scenario portfolio, which is supposedly optimal, proposedby the system. A series of mathematical iteration to adjust to optimalportfolio weights by correcting the existing weights may result incontinuous trading resulting in tremendous transaction costs. In manycases the final solution reached through continued trades might convergeeither with a dampening or explosive oscillation. Consequently, thepresent invention requests the investor to specify a tolerance level forthe expected return on the existing portfolio compared to that on ascenario portfolio in order to force an approximate solution duringcalculating an optimized performance of the existing portfolio.

[0110] Features and Architecture

[0111] An embodiment of the present invention includes the followinglogical or business components in the computer server 20:

[0112] Query component

[0113] Portfolio component

[0114] Accounting components

[0115] Monitoring components

[0116] Quote and chart components

[0117] User account information components

[0118] Each component is respectively a combination of software and/orhardware entities, such as a set of mathematical algorithm codes or anelectronic circuit, which describes the logic or performs a computation.

Query Component

[0119] A Query module of the computer server 20 assists the user inscreening stocks and selecting these into his/her portfolio. The userspecifies his/her investment requirements (e.g., the P/E ratio, etc.),preferences (e.g., the industry type, etc.) or other criteria to thecomputer server 20. The Query module then generate queries (e.g., a listof stocks satisfying the user requirements and preferences) based on theabove-mentioned user-specified data such as the industry type, P/Eratio, etc., and feeds back queries to the user. The user may selectstocks into his portfolio from the list returned by the query procedure.

[0120] The data used by the Query module to generate the query listtypically come from databases that are widely available with or withoutfees to the public over the Internet and other sources, and these datashould be updated by the computer server 20 frequently for maintainingthe most updated information of investment data.

Portfolio Component

[0121] The Portfolio Component includes several sub-modules for thecomputer server algorithms, trading strategies, portfolio preferences,and/or trading. One sub-module implements a predetermined mathematicalalgorithm derived from Modern Portfolio Theory, which determines thetypes and quantities of stocks, bonds and mutual funds to trade for theuser portfolio. The output of the computer server 20 engine is ascenario portfolio that is theoretically the most efficient portfoliofitting the user's investment objectives, given constraints imposed bypractical considerations, such as the size of a round of stocks.

[0122] Real time data of stocks is constantly monitored by the computerserver 20 to determine the values of the user's present existingportfolio and the scenario portfolio computed by the server engine.Expected returns of the stocks in the portfolios (existing or scenario),the actual track record of the present existing portfolio, and marketconditions are used to trigger actual trading of securities in theexisting portfolio when necessary.

[0123] Trading may be in a manual or an automatic mode. Automatic modemay be convenient for users/investors testing their investmentstrategies with “virtual cash”. Since the theoretically optimalportfolio may be slightly different at each point in time the triggeringmodule is used to limit the frequency of re-balancing.

[0124] The data used for this portfolio component comes from real timedata sources, such as current market quotes of stocks over the Internet,and the historic database, such as the previous closing quotes of thestocks. The database for all stock components in the existing portfolioshould be updated frequently.

Accounting Component

[0125] The accounting component maintains a double entry accountingsystem in the computer server 20. Information from account creating,transfers and trading is stored into a general ledger. The generalledger may be presented to the user for inspection whenever requested.

Monitoring Component

[0126] The performance-monitoring component tracks the users' portfoliosand the market returns. The update results are output in the form ofcharts to the users.

Quote and Chart Components

[0127] Quote and chart components are used to generate quotes for priceand trading history, or other related information of bonds, stocks, andmutual funds. Thus, they can be used to provide the users withinformation for research on individual stocks specified by the users.

User Account Information Components

[0128] User account information components maintain and extract userinformation such as email addresses and personal details.

Architecture

[0129] In a preferred embodiment, the logic implementation of thepresent invention is implemented in a modern three-tier architecture. Inaddition, all logic and computational algorithms are executed on thecomputer server 20. This allows for fast response time, minimalrequirements for the client system 10 (e.g., a PC or a PDA), andflexibility in deploying upgrades. The three-tier architecture of theinvention is illustrated in FIGS. 3-9 as:

[0130] Tier 1—User interface

[0131] Tier 2—Database server

[0132] Tier 3—TPS Application

Tier 1—User Interface

[0133] A user interface accepts information from a web server andpresents it to the users. Since no business logic is performed on theclient system, development of the user interface can be separated fromdevelopment of server application software. This eliminates softwareinstallation requirements on client systems (PCs or PDAs), other than anInternet browser enabling the users to communicate over the Inter- orIntranet. If necessary in the future, the entire user interface could beswitched or updated with minimal changes to the server applicationsoftware by a service provider.

Tier 2—Database Server

[0134] Stock market and portfolio information is maintained on adatabase server. The database server may be incorporated into thecomputer server 20 or may be independent from, but connected to, thecomputer server 20. The database server includes a market databasecontaining information relating to historic stock prices and companyfundamental data. The database server also includes a user database formaintaining information related to user information, portfoliopreferences, accounting, and portfolio performance.

Tier 3—TPS Application

[0135] The third or middle tier includes a web server, businesscomponents, and, in the case for large scale uses, an applicationserver. The business components may be independent to methods or meansused by the computer server 20 to relay and present information to theusers. Thus, they can be used within different server environments, forexample, with or without an application server.

[0136] Java Servlets are the glue between the web server and thebusiness components. These Java Servlets invoke the business componentsand relay the information retrieved or generated to the client browsersover the Inter- or Intranet. An HTML script type format, similar to theASP's widely used in the industry, can be used with Java Server pages.The HTML script is itself a specialized Java Servlet.

[0137] The application server provides a container for the businesscomponents to “live in.” It is used for a web site with heavy trafficwhere continuous availability is critical. It provides for loadbalancing and fail-over with a cluster of several server machines. Inother words, the computational load can be split over a number of servermachines without loss of the user's current session. If one servermachine is removed or unavailable from the cluster, the others will fillin to provide continuous service.

[0138] Platform

Software

[0139] The web site may be used by anyone with an Internet browser andan Internet connection. The web site is presented as HTML pages, JavaApplets, and GIF charts to maximize the interactive nature of the sitewhile minimizing the client PC requirements. In order that the site beused without any special plug-ins, Java 1.1 (AWT) Applets are used.However, the software and applications used may be updated as newtechnologies or software are constantly developed and available in themarket.

[0140] The server contains Java Servlets that send HTML outputs andcommunicate to Java Applets running on client PCs or PDAs via theInternet. In order to allow that any browser may be used and to permitaccess through firewalls, the communication method used between theclient systems and server is by HTTP tunneling.

[0141] In the preferred embodiment, the server programs have beendeveloped in Java for the following reasons:

[0142] More scaleable due to cross platform nature compared with otherpopular systems (e.g., server side scripting with VBScript orJavascript, Perl, and PHP) mostly used for smaller scale web sitedevelopment.

[0143] Allows for better organization, re-use of code, and maintenancecompared with scripting languages.

[0144] Easier to develop software as compared to systems previously usedfor large scale web site development (e.g., C++ with CGI, NSAPI, ISAPI,or server side Active X components from ASP)

[0145] Ease of use with Apache web server (currently with approximate60% of Internet), Microsoft IIS (currently with approximate 22% ofInternet), or other web servers as compared with other proprietarysystems.

[0146] Ease of use in a clustered environment through the use ofapplication servers compliant with the Sun EJB specification (e.g.,Sybase EA Server, BEA Weblogic, IBM Websphere, etc) to provide for usewith a large number of customers.

[0147] Publication of and widespread use of Java Application ProgrammingInterfaces (API's) by Sun allows many options for fundamental softwareand hardware used such as web servers, databases, and applicationservers, and server machines. Vendors for software conforming to thesespecifications include: Microsoft, Sybase, IBM, Oracle, Informix, BEA,Sun, and Hewlett Packard.

[0148] The server programs may run on any platform that supports Java.This means that web site components can be developed and tested oninexpensive Windows PCs or Linux servers and then moved to large-scaleUNIX servers for production use. The clustering ability means that thesite can continue to operate even if one machine is temporarily out oforder and the processing load can be balanced between server machines.The decision to add more powerful and expensive server machines can bedelayed until the network traffic demands it.

[0149] The selection of Java language in developing the server programsfor the preferred embodiment of the present invention is based on theabove-mentioned advantages provided by the Java language. However,future techniques or technology advancement may provide new solutionsother than Java for developing the server programs of TPS. As a result,the present invention is not limited in any sense by using the Javalanguage in the server programs of the preferred embodiment.

Security

[0150] In general, there are three most encountered security risks inoperating an online trading Internet business are:

[0151] External and unauthorized use of the Internet to gain access toserver machines and database contained therein;

[0152] “Spying” on Internet traffic in order to steal customers' accountor privacy information; and

[0153] Unauthorized physical access to server machines.

[0154] These potential security breach problems should be addressed andprevented when implementing the present invention. Many commercialsecurity programs are currently available for installation in thecomputer server 20. Alternatively, proprietary security programs may bedeveloped and/or incorporated into the server programs.

[0155] The described embodiments of the present invention are intendedto be exemplary and variations of the described embodiments may be madewithout deviating from the spirit and scope of the present invention asdefined in the appended claims.

What is claimed is:
 1. A method of portfolio management comprising:communicating with at least one investor through the Internet, receivinginvestment parameters from said at least one investor, and generating atleast one portfolio according to said investment parameters.
 2. Themethod of claim 1, further comprising: rebalancing said at least oneportfolio to generate a new portfolio.
 3. The method of claim 1, furthercomprising: formulating an investment index using Modern PortfolioTheory, ranking stocks in said investment index against said investmentparameters, and generating at least one optimum scenario portfolio basedon said ranking.
 4. The method of claim 1, further comprising:monitoring said portfolio to recommend at least one trade uponoccurrence of a triggering event.
 5. The method of claim 1, furthercomprising: automatically executing trades in accordance with saidinvestment parameters.
 6. The method of claim 1, further comprising:providing trade recommendations to the investor, which may be approvedor rejected by the investor.
 7. The method of claim 1, furthercomprising: generating at least one optimal scenario portfolio inaccordance with said investment parameters and current marketconditions.
 8. The method of claim 7, further comprising: comparingexpected returns of said optimal scenario portfolio with expectedreturns of at least one existing portfolio to provide traderecommendations.
 9. The method of claim 1, further comprising:generating a market index in accordance with said investment parameters.10. The method of claims 8 and 9, further comprising: comparing expectedreturns of said market index with expected returns of said optimalportfolio and said existing portfolio to provide trade recommendations.11. A method of portfolio management comprising: determining an optimalportfolio through the Internet by using investor questionnaires.
 12. Themethod of claim 11, further comprising: allowing investors to managemultiple numbers of funds simultaneously through the Internet.
 13. Themethod of claim 11, further comprising: providing educational materialsassociated with managing funds through the Internet.
 14. The method ofclaim 11, further comprising: managing at least one securities databasewith information comprising at least one of the following: industrytype; exchanges traded on; opening, closing and tick prices; bid and askprices; commission rates; applicable taxes; high and low prices; realtime and historical company fundamental, market and technical data, bothin real time and historically.
 15. The method of claim 11, furthercomprising: using data interpolation and extrapolations, and adjustmentsfor stock splits and dividends.
 16. The method of claim 11, furthercomprising: resampling bond, equity and mutual fund data in accordancewith at least one investor's investment planning horizon.
 17. The methodof claim 11, further comprising: regrouping securities for inclusion inan optimal portfolio in accordance with investor-specified criteria. 18.The method of claim 11, further comprising: generating at least oneunique market index based on investor-specified criteria.
 19. The methodof claim 11, further comprising: automatically computing assetallocation and managing at least one cash account in real time.
 20. Themethod of claim 11, further comprising: readjusting portfolio formationin accordance with an investor's asset allocation and cash managementcriteria.
 21. The method of claim 11, further comprising: computingrisk/return characteristics for analysis of bonds, stocks and mutualfunds.
 22. The method of claim 11, further comprising: providingfinancial planning worksheets which link to and communicate with atleast one of word processing, spreadsheet and database access programs.23. The method of claim 11, further comprising: selecting a set ofsecurities from at least one portfolio in order to avoid duplicateportfolios when more than one investor has identical investmentcriteria.
 24. The method of claim 11, further comprising: dynamicallyadjusting return-generating functions by stochastic processes, therebycomputing the means and the standard deviations of securities returns.25. The method of claim 11, further comprising: computing means andstandard deviations of a plurality of portfolios and generating anefficient portfolio frontier based upon said computation.
 26. The methodof claim 11, further comprising: generating an optimal portfolio byusing principles set out in Modern Portfolio Theory and using datacomprising bid/ask spreads, commissions and taxes.
 27. The method ofclaim 11, further comprising: computing an optimal portfolio weightafter all transactions costs and taxes have been deducted.
 28. Themethod of claim 11, further comprising: rebalancing at least oneportfolio in real time according to an investor's tactical portfoliostrategy, including a trading band.
 29. The method of claim 11, furthercomprising: placing orders in multiples of ten or one hundred shares andplacing buy orders after sell orders are placed and executed to ensurethat sufficient cash is available in a cash account.
 30. The method ofclaim 11, further comprising: blocking infinite numbers of continuousautomatic trading by introducing a tolerance or precision level withinwhich portfolio weights are optimally re-calculated.
 31. The method ofclaim 11, further comprising: providing transactional accounting ledgersto an investor through the Internet for tax purposes.
 32. The method ofclaim 11, further comprising: calculating an optimal scenario portfolioon the Internet at regular fixed intervals.
 33. The method of claim 11,further comprising: automating a basket-order portfolio system tradingtechnique on the Internet.
 34. The method of claim 11, furthercomprising: monitoring portfolio performance automatically through theInternet to determine whether the portfolio satisfies an investor'starget return to risk requirement.
 35. The method of claim 11, furthercomprising: providing a “Risk Thermostat” to show changing levels ofrisk for an existing portfolio in real time.